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David Gardner: Five costly tax mistakes to avoid

By David Gardner

Special to the Camera

Posted:
06/01/2014 09:08:10 AM MDT

David Gardner For the Camera

While most tax returns do not feature a four or five figure blunder, they happen more commonly than you'd think. Working with a professional tax preparer can help limit these errors, but even pros are not immune.

We request copies of their recent tax returns when we start working with clients. Mostly this is to understand their finances. But I confess we have an ulterior motive.

We absolutely love making recommendations to clients to reduce their taxes when merited, including filing an amended return if needed. While seeking solid investment returns with clients is rewarding, securing tax refunds is downright exhilarating. Those of you who have been paid interest by the IRS know what I mean.

Properly accounting for stock options.

Stock options, including Incentive Stock Options (ISOs) and Nonqualified Stock Options (NSOs) usually perplex taxpayers. Often tax pros are bewildered with their complexity. When you exercise an option and sell the related stock, it's critical to get it right. We've seen tax returns with double income taxes due to an option exercise and the sale of the related shares. When you take action on stock options, seek out help with this expertise.

Required distributions from IRAs and retirement plans.

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If you're far from retirement age, you may not be aware of the rules that require annual partial distributions from IRAs and retirement plans upon reaching age 70 ½. Luckily your financial institution will remind you of this. It's a good thing because the penalty for failing to take a minimum distribution is 50 percent of the distribution you should have taken.

Pitfalls with assets abroad.

Many Boulder County residents have financial assets overseas. If you are a U.S. person, generally defined as a citizen or resident, you must report worldwide income on your U.S. income taxes even if the asset is held overseas. Plus there are additional requirements to disclose the existence of financial accounts, even if they're not generating income. If you hold a combined total of over $10,000 in overseas financial assets at any point in the previous year, then you must file a so-called FBAR report with IRS. The penalties for not doing so are unbelievably harsh even if you have not intentionally misled the government. Make sure you work with a tax preparer that understands the ins and outs of disclosing the existence of these assets, particularly if you failed to do this in previous years.

Inherited assets.

Assets that you inherit generally receive a step up in basis to the value of date of death of the deceased. So if your father left you a house in the Newlands worth $750,000, that your parents paid $28,000 for in the 1970s, then no taxes may be owed on its sale. The same rules apply to inherited stocks and other assets. Make sure your tax preparer and the custodian of your investments understand that there's a new (presumably higher) basis.

Losing track of previous year tax benefits.

If you take a big loss on the sale of an asset, most likely you have a capital loss carryover. This loss can be used to offset future gains and $3,000 of ordinary income every year. But you need to track it from year to year. You may have basis in IRAs because of after-tax contributions. But if you don't document this on IRS Form 8606 each year, you could end up paying taxes on this money twice. If you exercise stock options, you may generate an AMT credit that can reduce taxes in future years. All of these data points must be collected every year. Every time you switch tax preparers or software packages, pay particular attention that this information is preserved.

David Gardner is a certified financial planner with a practice in Boulder County and can be reached through his website at yellowstonefinancial.com and on Twitter @Dave_CFP.

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